Kathy A. King v. Commissioner , 116 T.C. 198 ( 2001 )

116 T.C. No. 16UNITED STATES TAX COURT
KATHY A. KING, Petitioner AND
CURTIS T. FREEMAN, Intervenor v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5989-97. Filed April 10, 2001.
P claimed relief from joint liability under sec.
6013(e), I.R.C., which was repealed and replaced by
sec. 6015, I.R.C. Intervenor (I) is P’s former spouse,
who intervened pursuant to sec. 6015(e)(4), I.R.C., in
opposition to P’s claim for relief. See King v.
Commissioner, 115 T.C. 118 (2000). P and I filed a
joint income tax return for 1993, on which they claimed
a loss from a cattle-raising activity conducted by I.
The loss was disallowed by R on the ground that the
activity was not engaged in for profit under sec.
183(a), I.R.C.
1. Held: P meets all the requirements for relief
under sec. 6015(c), I.R.C., unless R demonstrates that
P had actual knowledge of the item giving rise to the
deficiency at the time she signed the return. See sec.
6015(c)(3)(C), I.R.C. When the item giving rise to the
deficiency is a disallowed deduction, such knowledge
must include knowledge of the factual circumstances
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giving rise to the disallowance of the deduction. In
this case, the fact giving rise to the disallowance was
I’s lack of a profit objective. R did not establish
that, at the time P signed the return, P had actual
knowledge that I, her spouse, did not have a primary
purpose or objective of making a profit under sec.
183(a), I.R.C., with respect to the activity that
generated the disallowed loss. Accordingly, P is
entitled to relief from joint liability.
2. Held, further, since the activity in question
was attributable solely to I, and there were no other
adjustments in the notice of deficiency, the relief to
P extends to the full amount of the deficiency.
Kathy A. King, pro se.
Curtis T. Freeman, pro se.
James R. Rich, for respondent.
OPINION
RUWE, Judge: This case was assigned to Special Trial Judge
D. Irvin Couvillion pursuant to section 7443A(b)(3)1 and Rules
180, 181, and 182. The Court agrees with and adopts the opinion
of the Special Trial Judge, which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
COUVILLION, Special Trial Judge: Respondent determined a
deficiency of $7,781 in petitioner’s Federal income tax for 1993.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
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The sole issue for decision is whether petitioner is
entitled to relief from joint liability under section 6015. The
underlying deficiency determined by respondent in the notice of
deficiency is not at issue. Curtis T. Freeman (intervenor) is
the former spouse of petitioner and filed an intervention in this
proceeding pursuant to section 6015(e)(4) objecting to the
granting of relief to petitioner under section 6015. See Interim
Rule 325; King v. Commissioner, 115 T.C. 118 (2000).
At the time the petition was filed, and at the time the
notice of intervention was filed, the legal residence of
petitioner and intervenor was Hartsville, South Carolina.
Petitioner and intervenor were married during 1982. During
1981, intervenor had purchased approximately 100 acres of land at
Hartsville, South Carolina, and had begun a cattle-raising
activity that continued for several years, including the 1993 tax
year at issue. This activity commenced with one or two cows,
then grew to a herd of 25-30 cows with intermittent sales and
purchases of cows and calves along the way. It was by no means a
profitable activity, although intervenor had the expectation
that, over time, the activity would become profitable.
Intervenor allowed some of his neighbors to pasture their
livestock on the property, and the neighbors, in turn, assisted
to some degree in caring for intervenor’s livestock when
intervenor was frequently away from home in connection with his
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sole income activity, a used car business. Petitioner frequently
visited the farm, with the children, and assisted minimally in
its operation. However, petitioner maintained or kept records of
sales, purchases, and expenses. She did not maintain a formal
set of books but made sure that all records were kept together
and submitted to their tax return preparer each year for
inclusion on the joint Federal income tax returns she and
intervenor filed. Petitioner knew that the cattle-raising
activity was not profitable, but she had expectations that, at
some point, the activity would become profitable. Petitioner and
intervenor separated in May 1993, and, thereafter, petitioner no
longer maintained records of the cattle-raising activity as she
had done in the past; however, she knew that intervenor continued
with the activity. The record does not show in what year
petitioner and intervenor commenced reporting the income and
expenses from the cattle-raising activity on their Federal income
tax returns, although the testimony at trial indicates that the
activity was reported on their joint income tax returns for the
years 1989 and thereafter. For the year 1993, petitioner and
intervenor reported gross income of $802, expenses of $28,199,
and a net loss of $27,397 from the cattle-raising activity on
Schedule C of their return, Profit or Loss From Business.
Petitioner and intervenor were divorced in May 1995. On
December 23, 1996, respondent issued separate notices of
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deficiency to petitioner and intervenor for the year 1993 and
determined in each notice a tax deficiency of $7,781. In these
notices of deficiency, respondent disallowed the $27,397 cattle
activity loss claimed on Schedule C of the 1993 joint Federal
income tax return. The basis for the disallowance was that the
cattle activity was not an activity engaged in for profit under
section 183. Respondent made no adjustments to the income or
expense amounts reported and claimed in connection with the
activity. The only other adjustments in the notices of
deficiency flowed from the disallowed cattle activity loss.
Petitioner filed a timely petition with this Court.
Intervenor did not petition this Court. Respondent, in due
course, assessed the deficiency against intervenor, but no
portion of that assessment has been paid, nor has intervenor
challenged the assessment in any other court.
In this case, petitioner does not challenge the disallowed
Schedule C cattle-raising activity loss. Her sole contention is
that she is entitled to relief from joint liability under section
6013(e). After the case was tried and taken under advisement,
section 6013(e) was repealed and was replaced with section 6015,
which retroactively applies to this case. Moreover, the
intervention emanates from section 6015(e)(4).2 The case was
2
See King v. Commissioner, 115 T.C. 118 (2000), for the
(continued...)
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again calendared for trial and heard pursuant to the provisions
of section 6015. Intervenor participated in the trial and
objected to petitioner’s being relieved of liability under
section 6015. In a supplemental trial memorandum, respondent
asserted that petitioner was not entitled to relief under section
6015(b) or (c).3
In Cheshire v. Commissioner, 115 T.C. 183, 189 (2000), the
Court succinctly set forth the legislative history of section
6015 as follows:
For many taxpayers, relief under section 6013(e) was
difficult to obtain. In order to make innocent spouse
relief more accessible, Congress repealed section 6013(e)
and enacted a new innocent spouse provision (section 6015)
in 1998 as part of the Internal Revenue Service
Restructuring and Reform Act of 1998 (RRA 1998), Pub. L.
105-206, sec. 3201(a), 112 Stat. 734. See H. Conf. Rept.
105-599, at 249 (1998). The newly enacted statute provided
three avenues of relief from joint and several liability:
(1) Section 6015(b)(1) (which is similar to former section
6013(e)) allows a spouse to escape completely joint and
several liability; (2) section 6015(b)(2) and (c) allow a
spouse to elect limited liability through relief from a
portion of the understatement or deficiency; and (3) section
6015(f) confers upon the Secretary discretion to grant
equitable relief in situations where relief is unavailable
under section 6015(b) or (c). Section 6015 generally
2
(...continued)
procedural history of this case.
3
Pursuant to the Court’s holding in King v. Commissioner,
supra, the Court’s order calendaring this case for further trial
stated that the only issue to be considered by the Court would be
petitioner’s claim for relief under sec. 6015, and the Court
would not consider any challenges to the underlying deficiency by
either petitioner or intervenor.
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applies to any liability for tax arising after July 22,
1998, and any liability for tax arising on or before July
22, 1998, that remains unpaid as of such date. See H. Conf.
Rept. 105-599, supra at 251.
We consider the merits of this case under section 6015(c),
which, in pertinent part, provides:
SEC. 6015(c). Procedures To Limit Liability for
Taxpayers No Longer Married or Taxpayers Legally Separated
or Not Living Together.--
(1) In general.--Except as provided in this
subsection, if an individual who has made a joint
return for any taxable year elects the application of
this subsection, the individual’s liability for any
deficiency which is assessed with respect to the return
shall not exceed the portion of such deficiency
properly allocable to the individual under subsection
(d).
(2) Burden of proof.--Except as provided in
subparagraph (A)(ii) or (C) of paragraph (3), each
individual who elects the application of this
subsection shall have the burden of proof with respect
to establishing the portion of any deficiency allocable
to such individual.
(3) Election.--
* * * * * * *
(C) Election not valid with respect to
certain deficiencies.--If the Secretary
demonstrates that an individual making an election
under this subsection had actual knowledge, at the
time such individual signed the return, of any
item giving rise to a deficiency (or portion
thereof) which is not allocable to such individual
under subsection (d), such election shall not
apply to such deficiency (or portion). * * *
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In Martin v. Commissioner, T.C. Memo. 2000-346, the Court
stated:
section 6015(c) relieves certain joint-filing taxpayers by
making them liable only for those items of which they had
actual knowledge, rather than being liable for all items
reportable on the joint return. In effect, this approach is
intended, to the extent permitted, to treat certain spouses
as though they had filed a separate return. This is a
departure from predecessor section 6013(e) and companion
section 6015(b) where the intended goal was to permit relief
only if the relief-seeking spouse did not know or had no
reason to know of an item.
Accordingly, taxpayers who are either no longer
married, separated (for 12 months or more), or not living
together * * * may elect treatment as though they had
separately filed. Section 6015(c)(3)(C), however, does not
permit the election of separate treatment for any item where
“the Secretary demonstrates that an individual * * * had
actual knowledge, [of the item] at the time such individual
signed the return”. * * *
In this case, the activity giving rise to the deficiency,
i.e., the cattle-raising activity, was attributable solely to
intervenor. As noted above, relief under section 6015(c)(3)(C)
is not available to petitioner if respondent demonstrates that
petitioner had actual knowledge of the item giving rise to the
deficiency.
In Cheshire v. Commissioner, supra, this Court held that,
where the spouse claiming relief under section 6015(b) or (c) had
actual knowledge of items of omitted income but did not have
knowledge “whether the entry on the return is or is not correct",
relief was not available. Id. at 195. In furtherance of the
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point, the Court stated:
In our opinion, the knowledge requirement of section
6015(c)(3)(C) does not require the electing spouse to
possess knowledge of the tax consequences arising from the
item giving rise to the deficiency or that the item reported
on the return is incorrect. Rather, the statute mandates
only a showing that the electing spouse actually knew of the
item on the return that gave rise to the deficiency (or
portion thereof). * * * [Id. at 194.]
See also Martin v. Commissioner, supra, where this Court stated:
“Thus, in Cheshire v. Commissioner, supra, we concluded that
ignorance of the applicable tax law is no excuse and that
respondent had met his burden of proving knowledge of the omitted
income.”4
The Cheshire case involved taxable retirement income
distributions received by the taxpayer’s spouse that were not
reported on the taxpayers’ joint income tax return. The Court
held that the “knowledge standard” for purposes of section
6015(c)(3)(C) “is an actual and clear awareness (as opposed to
reason to know) of the existence of an item which gives rise to
the deficiency (or portion thereof).” Cheshire v. Commissioner,
supra at 195. The Court further stated: “In the case of omitted
income (such as the situation involved herein), the electing
spouse must have an actual and clear awareness of the omitted
4
The quoted statement relates to sec. 6015(c)(3)(C), where
the Commissioner has the burden of proof with respect to
knowledge of the item giving rise to the deficiency.
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income.” Id. The Court appended to that statement a footnote
stating: “We leave to another day the manner in which the actual
knowledge standard will be applied in erroneous deduction cases.”
Id. n.6. Since the taxpayer’s claim for relief in Cheshire was
based solely on lack of knowledge of the tax consequences of the
unreported income, relief was denied under section 6015(c). This
case involves an erroneous deduction.
Respondent disallowed the deduction involved in this case
because petitioner’s former spouse lacked the necessary profit
objective. Even under prior section 6013(e), where the spouse
claiming relief was required to prove lack of knowledge of the
item, we said that “the taxpayer claiming innocent spouse * * *
[relief] must establish that he or she is unaware of the
circumstances that give rise to error on the tax return, and not
merely be unaware of the tax consequences.” Bokum v.
Commissioner, 94 T.C. 126, 145-146 (1990) (emphasis added), affd.
992 F.2d 1132 (11th Cir. 1993). As previously indicated,
Congress was attempting to expand relief from joint liability
when it enacted section 6015. When a spouse elects relief under
section 6015(c), the burden of proving the spouse’s actual
knowledge of the item in order to deny relief is on the
Commissioner.5 We therefore hold that the proper application of
5
See Culver v. Commissioner, 116 T.C. (2001) (the
(continued...)
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the actual knowledge standard in section 6015(c)(3)(C), in the
context of a disallowed deduction, requires respondent to prove
that petitioner had actual knowledge of the factual circumstances
which made the item unallowable as a deduction. Consistent with
Cheshire, such actual knowledge does not include knowledge of the
tax laws or knowledge of the legal consequences of the operative
facts.6
The factual basis for respondent’s determination in this
case was the lack of required profit objective on the part of
petitioner’s former spouse. Section 183(a) disallows any
deductions attributable to activities not engaged in for profit
except as provided under section 183(b). Section 183(c) defines
an activity not engaged in for profit as “any activity other than
one with respect to which deductions are allowable for the
taxable year under section 162 or under paragraph (1) or (2) of
section 212.” This case is appealable to the Court of Appeals
for the Fourth Circuit. The standard for determining whether
expenses of an activity are deductible under either section 162
5
(...continued)
Commissioner’s burden of proof under sec. 6015(c)(3)(C) is met by
a preponderance of the evidence).
6
We note that in Cheshire v. Commissioner, 115 T.C. 183(2000), the spouse claiming relief was found to have actual
knowledge of factual circumstances that caused the items of
omitted income to be taxable and that her omission was based on
her misunderstanding of the law.
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or section 212(1) or (2) in the Court of Appeals for the Fourth
Circuit is whether the taxpayer engaged in the activity primarily
for the purpose of making a profit. See Hendricks v.
Commissioner, 32 F.3d 94, 97 n.6 (4th Cir. 1994), affg. T.C.
Memo. 1993-396. While a reasonable expectation of profit is not
required, a taxpayer’s profit objective must be bona fide. See
Hulter v. Commissioner, 91 T.C. 371 (1988). Whether a taxpayer
is primarily engaged in the activity for profit is a question of
fact to be resolved from all relevant facts and circumstances.
See id. at 393; Golanty v. Commissioner, 72 T.C. 411, 426 (1979),
affd. without published opinion 647 F.2d 170 (9th Cir. 1981). In
resolving this factual question, greater weight is given to
objective facts than to the taxpayer’s after-the-fact statements
of intent. See Siegel v. Commissioner, 78 T.C. 659, 699 (1982);
sec. 1.183-2(a), Income Tax Regs.
Thus, several factors are taken into consideration in
determining whether an activity is engaged in primarily for
profit under section 183. Generally, these factors, set out in
section 1.183-2(b), Income Tax Regs., include: (1) The manner in
which the activity is conducted, (2) the taxpayer’s expertise,
(3) the time and effort expended in the activity, (4) an
expectation that the assets used in the activity may appreciate
in value, (5) the success of the taxpayer in other similar or
dissimilar activities, (6) the history of income or losses of the
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activity, (7) the taxpayer’s financial status, and (8) elements
indicating personal pleasure or recreation associated with the
activity. These factors are relevant in the context of this case
to the extent they may indicate whether petitioner knew or
believed that her former spouse was or was not engaged in the
cattle-raising activity primarily for profit.
The question in this case, therefore, is not whether
petitioner knew the tax consequences of a not-for-profit activity
but whether she knew or believed that her former spouse was not
engaged in the activity for the primary purpose of making a
profit. Thus, in determining whether petitioner had actual
knowledge of an improperly deducted item on the return, more is
required than petitioner’s knowledge that the deduction appears
on the return or that her former spouse operated an activity at a
loss. Whether petitioner had the requisite knowledge is an
essential fact respondent was required to establish under section
6015(c)(3)(C). Respondent failed in this regard. The Court is
satisfied that petitioner’s knowledge of the activity in question
was that it was an activity that she knew was not profitable but
that she hoped and expected would become profitable at some
point. Respondent presented insufficient evidence to show that
petitioner knew that her former spouse did not have a primary
objective of making a profit with his cattle-raising activity.
Petitioner, therefore, is entitled to relief from the tax
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liability arising out of this activity under section 6015(c).
Since the activity was an activity attributable solely to her
former spouse, the relief to petitioner extends to the full
amount of the deficiency.
Decision will be entered
for petitioner.